Sources of Government Revenue

Revenue collection by all levels of Government has grown dramatically.

Increased 800% since 1940

I. Economic Impact of TaxesA. Resource allocation – taxes can

raise or lower the cost of production and therefore affect supply which in turn will affect price which in turn will affect demand. Cutbacks in some industries mean resources will have to go elsewhere to other industries

B. Behavior Adjustment – some taxes are used to encourage or discourage certain behaviors. – Sin taxes are relatively high taxes placed on items the government wishes to discourage consumption of such as tobacco and liquor. Homeowners can deduct interest payments on home loans and this encourages home ownership.

C. Productivity and Growth – taxes can change our incentive to save, invest, and work.

D. The incidence of a tax is the final burden of the tax; it is easier for a producer to shift the incidence of a tax to the consumer if the demand is inelastic; the more elastic the demand, the more likely the producer will absorb much of the tax.

(see page 225 in textbook)

II. Criteria for effective taxes—A. Taxes are effective when they

are equitable, simple, and efficient

B. Equity – (fairness) taxes are considered fair if they have few loopholes – exceptions, deductions, and exemptions

C. Simplicity – easy to understand by the taxpayer. (income tax, sales tax)

D. Efficiency – easy to administer and successful at generating revenue

III. Two Principles of Taxation A. Benefits-Received principle –

those who benefit from the government goods and services should pay in proportion to the amount of benefits they receive.

B. This principle is limited because those who benefit are the least able to afford the taxes

C. The ability-to-pay principle – people should be taxed according to their ability to pay, regardless of the benefits they receive.

D. This principle is based on two ideas: that society can’t always measure the benefits derived from government spending and that people with higher incomes suffer less discomfort in paying taxes than people with lower incomes.

IV. Types of Taxes A. Proportional tax imposes the

same percentage on everyone, regardless of income

B. Progressive tax imposes higher percentage on those with higher incomes

C. Regressive tax imposes a higher percentage on low incomes

Section 2 – I. Individual Income taxesA. Established by the 16th

AmendmentB. Payroll withholding system

automatically deducts income taxes from an employee’s paycheck and sends it directly to the Internal Revenue Service

C. Individuals file a tax return after the close of the year and before April 15. If taxes withheld are more than taxes owed, you get a refund; if not, you owe the balance.

D. The individual income tax is progressive because people who earn more money, pay higher tax rates.

II. FICA taxesA. The Federal Insurance

Contributions Act tax pays for Social Security and medicare (flat tax of 1.45 percent)

B. FICA is the second largest source of government revenue

C. FICA is a regressive tax. Social Security is proportional up to a certain amount and then regressive; 6.3 percent of wages up to $87,000

III. Corporate Income TaxesA. Corporations pay a tax on their

profitsB. Corporate tax is the third largest

source of government revenue

IV. Other Federal TaxesA. Excise tax – a tax on the

manufacture of sale of certain items. (gas, liquor, tires, legal betting, coal etc.) These are regressive taxes because low income families spend larger portions of their income on these goods than do high-income families

B. The estate tax deals with the transfer of property when a person dies

C. The gift tax is placed on large donations of money or wealth and is paid by the donator

D. A custom duty is a charge levied on goods brought in from other countries

E. User fees are charged for the use of a good or service

F. User fees are based on the benefits received principle of taxation

Section 3I. State Government RevenueA. Intergovernmental revenue are

funds collected by one government and distributed to another level. States receive a lot of money from the federal government to help with education, highways, health and welfare.

B. Intergovernmental revenue is the largest source of revenue for state and local governments

C. Sales tax – levied on all consumer purchases; second largest source of income

D. Employee retirement contributions make up the third largest source of income

E. Individual income tax revenues make up the fourth largest source of revenue

F. Other sources include interest on surplus funds, fees from state owned colleges, universities, and schools, and corporate income taxes

II. Local Government Revenue Sources

A. Intergovernmental revenues usually earmarked for education and welfare

(largest source of local money)B. Property taxes (second largest

source of money)C. Government owned public

utilities and state-owned liquor stores

D. Hospital fees, personal taxes, public lotteries

III. Examining Your PaycheckA. Payroll withholding statement is

the summary of income and deductions

B. Additional deductions could be for retirement contributions, insurance, etc.

Section 4I. Tax ReformA. Economic Recovery Act – 1981

reduced taxes for individuals and businesses

B. Mid-1980’s tax code thought to favor the rich

C. 1986 – tax reform limited tax brackets to 15% and 28%

D. Omnibus Budget Reconciliation Act added two more higher tax brackets

E. 1997 – Taxpayer Relief Act – gave child credits and educational expense credits and reduced capital gains tax

F. 2003 – reduced the top four tax brackets and capital gains taxes.

II. The Value-Added Tax (VAT) A. Places a tax on the value that

manufacturers add to a good at each stage of production

B. Widely used in Europe but U.S. does not have it

C. Advantage is that the cost of the tax is spread out among producers and consumers

III. The Flat Tax A. Proportional tax on individual

income after a threshold has been reached

B. Advantages – simple to report; less loopholes; less need for tax accountants and IRS

C. Disadvantages – shifts tax policy away from the ability to pay principle and benefits those with high incomes and hurts those with low incomes

IV. Future ReformA. Simplified tax codeB. Unexpected economic

slowdowns decreases revenues and causes deficits

C. Unexpected political events such as 9/11 and the Iraqi War

D. New administrations always promise new tax laws